RBI favours liquidity limit on income, liquid funds

IL&FS default in August and September led to tight liquidity conditions and hike in funding costs for NBFCs.

Mumbai: The Reserve Bank of India (RBI) has suggested the regulators concerned impose a minimum liquidity limit on fixed-income and liquid fund schemes of mutual funds. The suggestion comes after the IL&FS debt crisis exposed gaps in the mutual fund industry’s approach to valuing fixed-income securities.

In its Financial Stability Report, RBI said that the valuation and maturity restrictions for these instruments are under review by Sebi. A mandatory liquidity limit may also be considered by the capital-markets regulator, it said. In this regard, RBI is working on strengthening the asset-liability management guidelines for the non-banking financial (NBFC) sector.

NBFCs borrow around 25%-30% of their funds from mutual funds. A report by Credit Suisse had said that mutual fund exposure t o NBFC debt, at 30% of assets under management, is rather outsized and unlikely to sustain. Of this debt, 55% is of short tenor.

“The recent episode in the wake of the IL&FS default underlined certain issues…the narrative on which can be broadly divided into nature of credit intermediation of MFs….the price impact of MF dislocation with specific focus on money market rates; fair value of corporate issuances in banks and MFs; and credit concentration in MF portfolios and possible behavioural implications,” RBI said in the report.

Mutual funds have about Rs 6,500 crore of IL&FS group exposure out of a total debt of around Rs 90,000 crore. Mutual funds passed the default risk on to investors.

IL&FS defaulted on debt obligations in August and September, leading to tight liquidity conditions and increase in funding costs for NBFCs. Asset liability mismatches at other NBFCs got recognised after the IL&FS default came to light. This resulted in redemption pressures.

“People have come to release that it carries risk. IL&FS was a grim reminder that mutual funds are subject to riskier markets,” said Dhirendra Kumar of Value Research, which is a research publication on Indian mutual funds.

The central bank noted that the extant valuation frameworks for corporate bond book appear to be falling short in terms of both benchmarking issues and valuation methods.

“A portfolio of corporate bonds that does not reflect the fair and exchangeable value of the underlying assets fails to serve as a barometer for the health of the underlying obligors and can potentially impose externalities on the rest of the market when investors prefer flight to safety as discrepancies in valuations get discovered,” said RBI in its report.